CH 1 Intro To International Economics

INTERNAL ECONOMICS deals with the economic interdependence among countries and includes the effects of such
interdependence and the factors which affect it. NATURE OF IE-1. Immobility of Factors of Production -Within a country,
labour and capital moves freely to get maximum returns. These factors of production do not move with such freedom among
different countries due to new culture, customs, etc. 2. Geographical and Climatic Differences and Differences in Natural
Resource Endowments: Each country has its unique climate which is responsible for agricultural products of that country e.g.,
raw jute from Bangladesh. 3. Differences in Market • Each country has varying market characteristics of weights and
measures, languages, fashions, tastes, parties to international trade. 4. Different Currency System: While a trader can
transact in Rupees while trading in India, he has to transact in Dollars, Pounds, Euros or Yen while trading with USA, UK,
Europe and Japan respectively. 5. Higher Transfer Costs: Because of the long distances involved transport costs for
international transactions are higher than for domestic trades. 6. Different Political Systems: In domestic trade, parties carry
transactions with due regard to national interests. Such loyalty is absent in international trade as each party aims at
maximum gain for itself. SCOPE OF IE-•Technical Progress - When a country has decided to specialize in the production of
particular goods with the help of particular technology, through international trade that technological knowledge spreads
worldwide. • Easy flow of Capital - LDC and UDC are suffering from acute shortage of capital. It is the international
economics which helps to flow capital resources from developed to underdeveloped areas. • Promotion of Competition - The
growing international transactions among the countries promotes competitions. • International Co-Operation - Modern
economic growth is closely associated with development and relationship. International trade promotes international co-
operation to fight against poverty, hunger and injustice. • Growth of international agencies - In order to promote trade
relations among the member countries several international institutions were established. As for example - The European
economic union. • Promotion of export trade - International economics always helps to promote export trade sector of the
member countries. This is because rising export denotes rising GDP. IMPORTANCE/SIGNIFICANCE OF IE-(i) It broadens the
mental outlook of people by enabling them to think and act beyond the narrow boundaries of nationalism. (ii) It makes them
realise the hard truth that national prosperity cannot be sustained for long in a world surrounded by poor nations. (ii) Its
study makes us realise that an important role has been played by foreign capital and labour in the past in the development of
national economies. (iv). It is very clear and obvious that no nation is self-sufficient with regard to factor endowment. Hence,
the nations have to exist and prosper they have to act in a spirit of mutual give-and-take. (v) A judicious study of
international economics stresses the inter-inevitability of mutual interdependence between nations in the process of growth.
(vi) The study of international economics causes development of international outlook among men of vision, statesmen and
economists. INTER-REGIONAL AND INTERNATIONAL TRADE-*Inter-regional trade refers to trade between regions within a
country. Ohlin calls it as inter-local trade. It is the domestic or internal trade. *International trade is trade between two
nations or countries. *The Classical economists held that there is a fundamental difference between the two types of trade,
whereas Modern economists like Bertil Ohlin believed that the differ between the inter-regional and international trade is of
degree and not of kind. DIFFER BTW Inter and Inter regional trade- - Definition, Currency exchange, Trade Restrictions,
Transportation Cost, goods traded, foreign reserve. *Internal trade is trade that involves buying and selling taking place
between two parties which are located within the political and geographical boundaries of a country * There is no exchange
of currency as trade takes place within the boundaries of the nation * No trade restrictions for internal trade *
Transportation cost is less when trade is taking place within the borders of a country *Only those goods and services are
traded that are available in the country *Does not generate any foreign reserve. * International trade is referred to as a trade
that involves buying and selling of goods between two individuals or businesses located in two different countries or it can
be trade between two different countries * Exchange of currency is there between the two countries/individuals/businesses
involved in the trade * International trade has different restrictions as the two countries involved in trade have different
policies with regards to trade * Comparatively higher transportation costs as goods need to be transported across the world
* Helps countries to trade goods that are produced in surplus or purchase goods that are scarcely available * International
trade generates foreign reserves for the two trading countries. TRADE AS ENGINE OF ECONOMIC GROWTH-The role of
foreign trade in economic development is very significant. The Classical and Neo-Classical economists have laid so much
importance to international trade in the development of any country that they came to regard it as an engine of growth.
IMPORTANCE OF FOREIGN TRADE IN ECONOMIC GROWTH-i. The primary function of foreign trade is to explore means of
procuring imports of capital goods, without which no process of development can start; ii. Trade provides for flow of
technology, which allows for increases in productivity, and also result in short-term multiplier effect; iii. Foreign trade
generates pressure for dynamic change through (a) competitive pressure from imports, (b) pressure of competing export
markets, - and (c) a better allocation of resources; iv. Exports allow fuller utilisation of capacity resulting in achievement of
economies of scale, separates production pattern from domestic demand, increases familiarity with absorption of new
technologies; v. foreign trade increases most workers’ welfare. It does so at least in four ways: (a) Larger exports translate
into higher wages; (b) because workers are also consumers, trade brings them immediate gains through products of imports;
vi. Increased openness to trade has been strongly associated with reduction in poverty in most developing countries. As the
historian Arnold Toynbee said ‘civilisation’ has been spread though ‘mimesis’, i.e., emulation or simply copying. (A) Direct
advantages: *When a country specialises, due to foreign trade and division of labour, in the production of a few goods it
exports those goods which it can produce relatively cheaper and in exchange can have what others can produce at a lower
cost. *This in turn, raises the level of output and the growth rate of economy. A higher level of output through trade tends to
break the vicious circle of poverty and in this way helps to promote economic development. *A developing country is
hampered by the small size of its domestic market which fails to absorb sufficient volume of output of products which it can
produce relatively cheaper. This forces the investment to be maintained at low level. *The existing resources are employed
more productively and the resource allocation becomes more efficient with the given production function. This reduces
underemployment and unemployment, increases domestic savings and investment. (B) Indirect advantages: (a) Check on
Inefficient Monopolies: International trade fosters development by encouraging healthy competition and checking inefficient
monopolies. For development it is essential to have healthy competition and check inefficient exploitative monopolies that
are usually established on the pretext of infant industry protection. (b) Important Educative Effects: International trade
induces an educative effect. In Haberler's words, international trade provides "the means and vehicle for the dissemination
of technical knowledge, the transmission of ideas, for the importance of know-how skills, managerial talents and
entrepreneurship. (c) Import of Capital Goods: Developing countries are generally capital-deficient nations. International
trade helps in import of capital goods against export of staple goods. (d) Basis for Inflow of Foreign Capital: International
trade provides the basis for the inflow of foreign capital into developing nations. Without foreign trade, there would be no
inflow of foreign capital from a developed country to a developing country. CRITICAL EVALUATION-*All these criticisms have
no empirical evidence to prove that the development of the export sector has been at the cost of the domestic sector. As
pointed out by Nurske," even unsteady growth through foreign trade is surely better than no growth at all". *The adverse
effects of the demonstration effect have also been exaggerated because emulation of higher standards of living act as
incentives to increased efforts and productivity on the part of the people of less developing nations. *Adoption of the
Western consumption standards tends to influence the subsistence sector favourably. Inclusion of milk, eggs, vegetables and
fruits in diet induces agriculturists to produce more for the market and thus increases investment of more capital and
improvements in agriculture, dairy and poultry production. *The problem of deterioration in the terms of trade of the fewer
developing countries is based on obsolete data. According to GATT, they import only 1/3rd of their total consumption of
manufactured articles and even this proportion is on the decline. *On the other hand, their export consists of textiles,
machine tools, steel and a variety of manufactured consumer goods. The deterioration in terms of trade is due to inflationary
pressures leading to high costs and prices and external deficit and not the declining world demand for their primary goods.
INTERNATIONAL TRADE FLOWS-Trade Flows: •Trade flows are the buying and selling of goods and services between
countries. Trade flows measure the balance of trade (exports-imports). This is the amount of goods that one country sells to
other countries minus the amount of goods that a country buys from other countries. *There are three types of international
trade (i) Export Trade, (ii) Import Trade and (iii) Entrepot Trade Influential Factors Affecting Foreign Trade are as follows:
*Impact of Inflation *Impact of National Income *Impact of Government Policies *Subsidies for Exporters *Restrictions on
imports *Lack of Restrictions on Piracy *Impact of Exchange Rates. International Trade-•International trade is the exchange
of capital, goods, and services across international borders or territories because there is a need or want of goods or
services. Most traded export products: 1. Mineral fuels, oils, distillation products, etc 2. Electrical, electronic equipment 3.
Machinery, nuclear reactors, boilers, etc. Largest countries by total international trade-1. USA 2. China 3. Germany.

Ch 2 Theories of International Trade

ADAM SMITH: ABSOLUTE COST ADVANTAGE THEORY-Introduction-*Adam Smith, the Father of Economics, believed that
the basis of international trade was absolute cost advantage. *According to his theory of Absolute Cost Advantage, trade
between two countries would be mutually beneficial if one country could produce one commodity at an absolute advantage
(over the other country) and the other country could, in turn, produce another commodity at an absolute advantage over
the first country. Example of Absolute Cost Advantage-absolute cost advantage is the nation’s capacity to have
specialization and greatness in production than other nations. For such, a nation is not dependent on any other nations. The
following example will further make it simple to understand what the actually the concept of absolute
cost advantage theory. Let’s suppose, there are two countries Ghana and South Korea, both have the same number of
resources. For Ghana to produce 1 ton of Cocoa would cost 10 resources, in the same way, it would cost 20 resources to
produce 1 ton of rice. Similarly, South Korea would cost 20 resources to produce 1 ton of Cocoa and 10 resources for 1 ton of
Rice. It clearly represents that Ghana would get an absolute cost advantage in the production of Cocoa and South Korea get
in the production of Rice. According to Smith, countries should specialize in the production of goods for which they have an
absolute cost advantage and then trade these goods for those produced by other countries. According to this theory, Ghana
should specialize in the production of Cocoa, while South Korea should specialize in the production of Rice. Ghana Could get
all the rice it needed by selling its cocoa to South Korea and South Korea selling rice and buying cocoa from Ghana . Thus,
absolute cost advantage theory explains trade takes place when one nation can produce a good at a lower cost than another
nation can. Criticism-1. There is lack of clarity and it is a vague explanation. 2. According to Ellsworth, Smith assumes that an
exporting country must be able to produce with a given amount of labour and capital a larger output than any rival but this
may not be realistic as there are many underdeveloped countries which have no absolute advantage in production of any
commodity, yet have trade relations with other countries. 3. It can be said that Smith's analysis is weak and unrealistic.
RICARDO'S COMPARATIVE COST THEORY -Introduction-•According to David Ricardo, it is not the absolute but the
comparative cost differences that determine trade relations between two countries. •Due to differences in climate, natural
resources, geographical situation and efficiency of labour, a country can produce one commodity at a lower cost than the
other. In this way, each country specialises in the production of that commodity in which its comparative cost of production
is the least. •Therefore, when a country enters into trade with some other country, it will concentrate on the production of
those goods and services in which it has cost advantages and exchange them with the goods and services - produced by
other countries for the production of which it was either less suited or had positive 'cost disadvantages'. ASSUMPTIONS of
the Ricardian Theory-(1) The Ricardian model is of two-country, two- commodity. (ii) They produce the same two
commodities. (iii) Production costs meant only labour costs. Labour was assured to be the only productive factor. Hence,
costs were to be treated as labour cost alone. It also means prices of two commodities are determined by labour cost. (iv) All
labour was assumed to be homogenous. (v) It assumes that there are no transportation charges. (vi) Production is subject to
constant costs. That is, changes in output are not supposed to influence the unit cost of production. EXPLANATION of the
Ricardian Theory-(A) Absolute Cost Difference (Adam Smith's Theory): Adam Smith argued that international trade is
advantageous for all the participating countries only if they enjoy absolute differences in the cost of production of the
commodity in which they specialise. (B) Equal Differences: If there are equal differences in production costs, international
trade cannot take place. There is hardly any possibility of profit in international trade when there are equal differences in
production costs between the two countries and international trade comes to an end. ( C) Comparative Cost Differences: •
Ricardo shows that trade is possible between two countries even when one country has an absolute advantage in the
production of both goods, but a comparative advantage in the production of one commodity than in the other. *We take the
well-known example as given by Ricardo to explain the theory of comparative cost differences. It is trade between two
countries - Britain and Portugal, two commodities - cloth and wine. *David Ricardo in his model of a two-country, two
commodity worlds, pointed out that Portugal could produce both wine and cloth cheaper than Britain, but it possessed a
greater cost advantage in wine than in cloth. Hence, it was in the interest of Portugal to concentrate on the production of
wine and leave the production of cloth to Britain. CRITICAL EVALUATION-1. 2x2 Model Unrealistic: The Ricardian model is
related to trade between two countries and two commodities. This is an unrealistic assumption as international trade is
between many countries and trading in many commodities. 2. No Free Trade: A serious weakness of the doctrine is that it is
based on the assumption of perfect and free world trade. But, in reality, there is no free trade. In fact, every country applies
restrictions on the free movement of goods to and from other countries. 3. Heterogeneous Labour: *The labour cost theory
is based on the assumption of 'homogenous labour'. This cannot be true because labour is heterogeneous. It is different in
kind, grade, specialisation etc. 4. Similarity in Tastes in the Two Countries: *The assumption of similar tastes is far from reality
because tastes differ with difference in income in a country. *Moreover, they also change with the growth in an economy
and with the development of its trade relations with other countries. 5. Self-Interest as a Hindrance: The theory does not
hold good if a country having a comparative disadvantage does not wish to import a commodity from the other country due
to strategic, military or development considerations. Hence, very often it is self-interest that stands in the operation of the
theory of comparative costs. 6. Technical Know-How to Remain the Same: The theory neglects the role of technological
improvements in international trade. This is a serious setback because technological changes help in increasing the supply of
goods for the domestic and international market. Further, improved technology can reduce the costs. World trade has
gained much from innovations, research and development. HECKSCHER-OHLIN THEORY-*Certain countries have
extensive oil reserves but have very little iron ore. Meanwhile, other countries can easily access and store  precious metals,
but they have little in the way of agriculture. *For example, the Netherlands exported almost $577 million in U.S. dollars in
2019, compared to imports that year of approximately $515 million. Its top import-export partner was
Germany.5 Importing on a close to equal basis allowed it to more efficiently and economically manufacture and provide its
exports. *The model emphasizes the benefits of international trade and the global benefits to everyone when each country
puts the most effort into exporting resources that are domestically naturally  abundant. All countries benefit when they
import the resources they naturally lack. Because a nation does not have to rely solely on internal markets, it can take
advantage of elastic demand. The cost of labor increases and marginal productivity declines as more countries and
emerging markets develop. Trading internationally allows countries to adjust to capital-intensive goods production,
which would not be possible if each country only sold goods internally. The H. O. Theory Statement • The H-O theory states
that the main determinant of the pattern of production, specialisation and trade among regions is the relative availability of
factor endowments and factor prices. Regions or countries have different factor endowments and factor prices. That is, some
countries have much capital, others have much labour. • According to this theory, "Countries that are rich in capital will
export capital - intensive goods and countries that have much labour will export labour- intensive goods". *To Ohlin, always
the immediate reasons of international trade are that some goods can be bought more cheaply from other regions and it can
be produced at a high price in the same region. Hence, the main cause of trade between regions is the difference in prices of
commodities and this difference is due to relative factor endowments and factor prices. ASSUMPTION of the Theory- (a) It is
a 2 x 2 x 2 model Le. two countries, two commodities and two factors of production (labour and capital). (b) The factors of
production are perfectly mobile within the regions, but immobile between the two (c) There are no restrictions on the
movement of goods between the two regions. (d) There are no transportation costs. (e) Each region possesses a paper
currency system which is insulated from external financial influences. (f) The two countries in the theory cited - one is labour-
intensive country and the other is capital-intensive country. (g) Goods transactions alone are to be considered; exports will
then exactly balance with imports. (h) There are no qualitative differences in the factor of production in the two regions. (i)
Resources are fully-employed. (j) There is perfect competition in commodity and in factor markets. CRITICISM-*Poor
prediction and performance. *The unfair assumption is that all labor is employed. This model assumes that all work in the
country is engaged, thus ignoring the concept of unemployment. *The unrealistic assumption is that similar production
exists. Furthermore, this model assumes that nations have the same technology used for production, undermining the
effects and ignoring the technological gaps. *The unrealistic assumption is that similar production exists. Furthermore, this
model assumes that nations have the same technology used for production, undermining the effects and ignoring the
technological gaps. *To sum up, this model postulates that countries export what they can produce. This model proposes
that countries export what they can create abundantly or what they are already in the abundance of (reserves). A country
will have a comparative advantage in the good that intensively uses its relatively abundant factor. Though this model has
been proven to be better than the traditional model, this model adopts assumptions that can hardly be expected to be
fulfilled. HECKSCHER OHLIN MODEL SUPERIOR TO CLASSICAL THEORY? *It is a better explanation of the
world economy after World War II. *The traditional Ricardian theory overlooked the demand factors and completely focused
on the supply factors. The H-O model is relatively better and considers both supply and demand. *The classical theory
ignored capital and assumed labor as the only factor of production. *Hence, the classical theory accredits any difference in
costs to the differences in labor. *The H-O model is more specific and realistic when compared to the classical approach.
*This model also brings about integration between trade theories and value theories. EMPIRICAL EVIDENCE OF TRADE
THEORY-*Empirical research in international trade until recently was the poor relation of its theoretical sibling, but has
undergone a resurgence over the last twenty years. 1. Traditional Trade Empirics: *The idea that comparative advantage
gives an explanation for inter-industry trade. *The international exchange of one set of goods for other dates back to Ricardo
(1817), who emphasized technology difference as the source of cross-country variation in opportunity costs of production.
*While some early empirical studies adopted a Ricardian perspective much of the empirical analysis of traditional trade
frameworks has been concerned with the Heckscher 1919 and Ohlin 1924. *The HO model assumes that countries have
similar technologies and instead emphasizes variation in country factor endowments and industry factor intensities as the
source of differences in opportunity cost of production. *The stylized version of the HO model assumes two factors of
production (capital and labour), two countries (one capital abundant), and two goods (one capital intensive at all factors
prices. *The model yields four predictions: (a) The HO Theorem: • The capital abundant country exports the capital intensive
good. (b) The Factor Price Equalization Theorem: -• With diversified production, an increase in the relative price of the
labour-intensive good raises the relative and real return to labour and reduces the relative and real return to capital. (c) The
Stopler Samuelson Theorem: • With diversified production, an increase in the relative price of the labour-intensive good
raises the relative and real return to labour and reduces the relative and real return to capital. (d) The Rybczynski Theorem: •
With diversion production, an increase in the endowment of labour leads more than proportionate increase in the output of
the labour-intensive goods. • Early empirical examinations of the HO model were loosely motivated by these four theorems.
In seeking to test the HO Theorem, Leontief (1953) found that U.S. exports were less capital-intensive than U.S. imports,
which appeared paradoxical within the confines of the stylized HO model. The key to resolving this paradox in Leamer (1980)
was in rigorously deriving the correct empirical predictions directly from the theory. Indeed, a distinguishing feature of
recent empirical studies of the HO model has been the derivation of empirical specifications from general equilibrium trade
theory and the explicit recognition of the complexity of the modifies predictions with many goods and factors of production.
2. New Trade Empirics: • Although traditional trade theory emphasizes the international exchange of one set of goods for
another (inter-industry trade) due to comparative advantage (dissimilar countries), much of international trade involves the
two-way exchange of goods within industries (intra-industry trade) between developed nations (similar countries). *This
apparent disconnect between theory and data was documented in a number of early empirical studies, which examined the
extent of intra-industry trade (e.g. Grubel and Lloyd 1975) and the volume of trade between similar countries (e.g. Linder
1961). This empirical evidence was a key motivation for the new trade theory literature following Krugman (1979, 1980) that
explained these features of international trade in terms of consumer love of variety and increasing returns to scale. *Firms
manufacture differentiated products and concentrate production in a single location, while consumers spread their
expenditure across all firms varieties, giving rise to two-way trade even if countries are identical. Although not the only
explanation for intra-industry trade between similar countries (see Davis 1997). the combination of consumer love of variety
and increasing returns to scale provided an entirely new intellectual framework for thinking about the causes and
consequences of international trade. 3. The Empirics of Product Trade-• The dissemination of highly disaggregated datasets
on trade in thousands of individual products (Feenstra et al. 2002, 2005) has contributed towards a shift in focus in empirical
trade research towards the micro level. For the United States, data are available for over 7,000 seven-digit products of the
Tarif Schedule of the United States (TS7) from 1972 to 1988 and for over 10,000 ten-digit products of the Harmonized System
(HS10) from 1989 onwards. In contrast to the empirical research on the HO model discussed above, which emphasizes
specialization across products or industries, Schott (2004) provides compelling evidence of specialization within products.
Taking U.S. manufacturing imports as a whole in 1994, and defining the unit value ratio (UVR) as the ratio of value to
quantity, the maximum UVR within products across trade partners is a factor of 24 times greater than the minimum UVR 4.
The Empirics of Plant and Firm • Trade The analysis of micro datasets on plants and firms has raised additional empirical
challenges for traditional and new trade theory and prompted a wave of subsequent theoretical research. The first set of
empirical challenges relates to producer heterogeneity and persistent reallocation. *Whereas traditional and new trade
theories typically assume a representative firm, micro datasets reveal vast heterogeneity across plants and firms within
narrowly- defined industries, in terms of productivity, capital intensity, skill intensity and other characteristics. Similarly,
whereas traditional trade theory emphasizes net reallocations of resources between industries in response to exogenous
shocks such as trade liberalization, micro datasets reveal persistent job creation and job destruction in all industries even in
the apparent absence of exogenous shocks. 5. The Empirics of Trade Policy-A final area of rapid recent progress is the
empirical analysis of trade policy. A number of alternative approaches to modelling the political economy of trade policy
have been taken, including median-voter theories, models where the government trades of political support from industry
against consumer dissatisfaction, theories of lobbying by special interest groups, and models of electoral contribution.

CH 3 Terms of Trade and Gains from International Trade

Terms of trade (TOT) represent the ratio between a country's export prices and its import prices. TOT indexes are defined
as the value of a country's total exports minus total imports. The ratio is calculated by dividing the price of the exports by
the price of the imports and multiplying the result by 100.
Concepts of Terms of Trade : Barter terms of Trade and Income Terms of Trade
• The 'terms of trade' refers to the rate at which a country's exports exchange for its imports. • The measurement of the
terms of trade can be understood by the following concepts:
1. Barter Terms of Trade. Barter terms of trade can be classified into:
(i) Net Barter Terms of Trade (NBTT): • This concept of the terms of trade was first introduced by the American economist, F.
W. Taussig. It is also referred as "commodity terms of trade".
*NBTT refers to the ratio between the prices of exports and imports at a given period compared to an earlier period.
Symbolically, Tc= Px/ Pm
Here, Px and Pm are prices of exports and imports respectively. Tc= Net barter terms of trade.
• In order to compare changes in terms of trade between two periods, the ratio will be represented as:
Px1/Pm1 : Px0/ Pm0 (here, 1 refers to current period, O refers to base year).
The NBTT in the base year is equal to 1 as (P x0/Pm1 = 100/100 =1)
Suppose that in the current year the export price index is 170 and import price index is 120, then
Tc=170/120: 100/100 =1.4:1
or it shows an improvement to the extent of 40% in NBTT.
• Thus, when export prices rises in relation to import prices, the commodity/NBTT is said to have become favourable to the
country.
Significance of Net Barter terms of Trade • The concept is widely employed by the economist for measuring and evaluating
short-term changes in the trading fortunes of a country.
• It expresses the purchasing power of a country's exports in terms of imports.
Limitations: 1. Problems Related to Index Numbers: • All the problems associated with index numbers such as the base year,
coverage, method of calculation arise.
2. No account in Quality of Product: • The NBTT are based or, the index numbers of export and import prices. But it does not
take into account the changes taking place in the quality and composition of goods entering into trade between the two
countries. *At best it can show the changes in the relative prices of goods exported and imported in the base year, but fail to
consider the new goods that are constantly entering in international trade.
3. Selection of Period: • Problem arises regarding the selection of period. The selection of period over which the terms of
trade are studied and compared should not be too short as it would not give meaningful change between the base date and
the current date. • The period selected should not be too long as in meantime the structure of the country's trade might
have changed and it is difficult to compare the export and import commodity contents.
4. Changes in Prices: • NBTT simply shows changes in export and import prices but does not reveal how such price change
has taken place. That is, the commodity terms of trade index does not take into account the effects of the factors influencing
the price changes
5. Nation's Import Capacity: * The concept of NBTT explains nothing about the 'capacity to import of a country. Suppose
there is a fall in the commodity terms of trade in India which implies that a given quantity of Indian exports will buy a smaller
quantity of imports than before. • Further, suppose that the volume of Indian exports rises due to fall in the prices of
exports. With these two trends operating, it may keep India's capacity to import the same as before or may improve it. Thus,
the commodity terms of trade throws no light on the country's capacity to import.
6. Ignores Change in Productive Capacity: • NBTT does not consider the change in productive efficiency of a country, which
when increases can bring down the cost of production and the prices of export goods. Fall in export prices may worsen the
commodity terms of trade. But, in reality, even though a given value of exports can be exchanged for less imports, the
country will be still better off than before as the given volume of exports can be produced with lesser resources.
7. Not Applicable to Balance of Payments Completely: *The concept of NBTT is applicable if the balance of payments (BOP) of
a country includes only the exports and imports of goods and services and only when the BOP balances in the base and the
given years.
*But, if BOP includes unilateral payments or unrequired exports and/or imports, such as gifts, tributes, etc., from and to the
other country, causing disequilibrium in the BOP, the concept of NBTT is not helpful in measuring the gains from trade.
8. Fails to Explain Distribution of Gains: • The concept of NBTT fails to explain the distribution of gains from trade between a
developed and underdeveloped country. If the export price index of an underdeveloped country rises more than its import
price index, it implies an improvement in its terms of trade. But if there is an equivalent rise in profits of foreign investments,
there is no gains from trade.
(ii) Gross Barter Terms of Trade (GBTT): *To overcome the defects of NBTT, F. W. Taussig devised the new concept of Gross
Barter terms of trade (GBTT).
• GBTT refers to the ratio of the total physical quantity of importable to the total physical quantity of exportable.
• The higher is the ratio between quantities of imports and exports, the more favourable the GBTT for the country in
question. A larger quantity of imports can be had for the same volume of exports.
Symbolically, Tg= Qm/Qx
Here, Qm = quantity of imports: Qx = quantity of exports; Tg=Gross barter terms of trade.
• To measure changes in GBTT over a period, the index number of the quantities of imports and exports in base period and
the end period are related to each other. Symbolically. T g=Qm1/Qm0/ Qx1/Qx0.
Suppose the import index rises to 180 whereas export index rises to 120, then
Tg=180/120:100/100 = 1.5:1
That is, it shows an improvement of 50% in the GBTT of the country.
If the quantity of import index had risen by 130 and that of quantity exports by 180, then GBTT would be-
Tg=130/100/180/100=72.22
• This implies deterioration in the terms of trade by 18 percent in the given period when compared to the base year.
*When Tc (Net barter terms of trade) and Tg (Gross barter terms of trade) of the country has balance of trade equilibrium. It
shows that total receipts from exports of goods equal total payments for import goods.
Symbolically. Px x Qx= Pm x Qm
Alternatively, Px/Pm=Qm/Qx
Significance of GBTT-The GBTT ratio compares physical quantities of export and import Le, a ratio of real changes. It is a
measure in real terms.
Limitations/Criticism of GBTT-(a) Not Comprehensive: The concept of GBTT is concerned exclusively with export and import
goods. It implies that it does not include within itself capital transactions among the trading nations.
(b) GBTT does not Portray Real Situation: • The concept of GBTT may not portray the real situation. An improvement in GBTT
is regarded as an index of a higher level of welfare from trade. But this may not be true if tastes, preferences and habits of
the people change so that the country needs less imports that give greater satisfaction. However, it will lead to unfavourable
GBTT but improve welfare. Thus, it does not show the real situation.
(c) Overlooks Improvements in Production: *GBTT measures the physical quantities of exports and imports but ignores
qualitative improvements in the production of export and import goods. (d) Ignores Improvement in Factor Productivity: • A
country may have unfavourable GBTT due to increase in factor productivity in the export sector. But an increase in factor
productivity will show gains for the exporting country.
(e) GBTT is an Impracticable Concept: • The concept of GBTT aggregates all types of goods and capital payments and receipts
as one group in the index numbers of exports and imports. No units are applicable in equal terms to commodities like wheat
and to steel, or to export or import of capital and the payment or receipt of a grant. Thus, it is difficult to distinguish between
the various types of transactions which are totalled together in the index. Economists like Viner, Haberler and others have
dismissed this concept as unreal and in statistical context.
2. Income Terms of Trade. *This concept was a refinement over Net Barter Terms of Trade (NBTT) and was presented by G.
S. Dorrance.
*Income terms of Trade may be defined as, "the index of the value of exports divided by the price index for imports".
Symbolically, Ty= Px x Qx/Pm (or Ty= Tc x Qx as Tc = Px/Pm)
*Income terms of trade are also referred to a country's "capacity to import". In the long run, the total value of exports of a
country must equal to its total value of imports.
That is, Px x Qx=Pm x Qm (or Px x Qx/Pm=Qm).
Thus, Px x Qx / Pm decides Qm, i.e. the total volume that a country can import.
Other things being the same, the 'capacity to import of a country can increase by.
*The rise in price of exports (P.); or
*The fall in price of imports (P); or
*The rise in the volume of its exports (Q.).
Income terms of trade takes into account the volume of exports of a country and its export and import prices (the net barter
terms of trade).
With 1970 as base year- and if in 1980 P, 140, Pm = 70, Q. =80, then
Ty= 140x80/70=160, showing an improvement by 60 percent in income terms of trade in 1980 when compared to base
period 1970.
On the other hand, if in 1980, Px= 80, Pm= 160 and Qx = 120 then,
Ty=140x80/70=160, showing deterioration by 40 percent in income terms of trade in 1980 when compared to base period
1970.
1. A rise in the income terms of trade index means that a country can import more goods in exchange for its exports.
2. Even when its income terms of trade index may improve, its commodity terms of trade or NBTT may deteriorate. For
example, keeping import prices to be constant, and export prices fall, there will be an increase in the sales and value of
exports. Thus, while the income terms of trade may have improved and NBTT might have deteriorated.
Significance 1. This concept is of special importance to less developing countries in view of their increasing imports.
2. It brings to light an important fact to less developing countries that they are in no position to determine the quantum of
imports as they have no control over the export prices. Thus, this concept brings out the economic helplessness of
developing countries in relation to developed countries.
Limitations/Criticism-1. Inferior Concept of NBTT: • As the index of income terms of trade is based on commodity terms of
trade and leads to conflicting results. Thus, the concept of NBTT is usually used in preference to the income terms of trade
concept for measuring the gains from international trade.
2. Not a Good Measure:• The index of income terms of trade fails to measure exactly the gain or loss from external trade.
When the capacity to import of a country increases, it means that it is also exporting more than before.
3. Ignores Total Capacity to Import: • This concept is related to the export based capacity to import (ie, country can import
equivalent to its exports) but ignores the total capacity to import of a country which includes its foreign exchange receipts.
For example, if the income terms of trade index of a country has deteriorated but actually its receipts from foreign exchange
has increased then it can be said that its capacity to import has increased and not deteriorated.
FACTORS INFLUENCING TERMS OF TRADE: MNC's AND FOREIGN DIRECT INVESTMENT-Factors Affecting Terms of Trade-
The terms of trade of a country are influenced by a number of factors as discussed below:
1. Reciprocal Demand: • The terms of trade of a country depends upon the reciprocal demand, ie, the strength and elasticity
of each country's demand for the other country's product.
*Suppose there are two countries, Germany and England, which produce linen and cloth respectively. If Germany's demand
for England's cloth is inelastic (ie, intense), the price of cloth rises more than the price of linen.
*The commodity terms of trade will move against Germany and in favour of England. It can be contrary when the price of
linen rises as compared to price of cloth from England.
2. Economic Growth: Economic growth of a country will cause an outward shift of the production possibility curve allowing
larger output.
*The upward shift in production possibility curve may occur due to increase in the supply of the factors of production and
technological improvements allowing greater aggregate output with given quantity of resources.
*The impact of economic growth on the terms of trade will depend on the pattern of the country's economic growth.
*If the economic growth is balanced, ie, if the export and import sectors grow at the same rate, the terms of trade will
remain unaffected.
*If the growth is ultra-export-biased the country will produce more quantity of the export goods at the cost of import
substitutes, the terms of trade will be unfavourable.
*The reason is that if export goods are plenty but world demand for these goods have not increased at the same rate, the
prices will fall. At the same time, the import goods are scarce in the domestic market as they have been substituted by
export goods. More goods have to be imported and prices may rise making the terms of trade against the country.
*If the economic growth is import-biased, i.e., production of import goods will rise at home and reduce the quantity of
import goods demanded.
*The country will be willing to offer a lesser quantity of export goods for the import goods and terms of trade will become
favourable.
3. Shift in the Demand for Exports/Imports: In an equilibrium position, at particular terms of trade, the total value of exports
of one country should be equal to the total value of its imports.
*Other things remaining the same, if the demand for imports of country increases. the prices of imports in relation to the
prices of exports will increase. As a result, the commodity terms of trade of the country will deteriorate the net barter terms
of trade.
*The increase in demand for imports may be due to several reasons such as rise in disposable personal income or
demonstration effect or shift in production techniques requiring more capital inputs, etc. On the other hand, if the demand
for the exports of the country increases, the prices of its exports in relation to the prices of its imports will increase and the
commodity terms of trade of the country will improve.
4. Change in Tastes: • Terms of trade of a country are also affected by the change in tastes of people of that country.
Suppose England's taste shift from Germany's linen to its own cloth, then England would export less cloth to Germany and its
demand for Germany's linen would also fall. Thus England's terms of trade will improve. On the other hand, a change in
England's taste for Germany's linen would increase its demand and hence the terms of trade would deteriorate for England.
5. Import Substitutes: If close substitutes of import goods are available in large quantity in the country. the bargaining power
will be weak and the terms of trade will be unfavourable for the exporting country. On the other hand, in the absence of
availability of close substitutes, the bargaining power will be strong and the terms of trade will be favourable for the
exporting country.
6. Tariff & Terms of Trade: • A country may levy an import tariff in order to improve its terms of trade. When a country
imposes tariff on its imports, its willingness to take imports is reduced. The imposition of a tariff duty will make the price of
the import good higher and may reduce the importing country's willingness to import.
*In this manner, with the given quantity of exports, imports reduced, the net barter terms of trade will improve.
MNC's and Foreign Direct Investment-*A Multinational Corporation" (MNC) can be defined as an enterprise that conducts
and controls productive activities in more than one country.
*Foreign Direct Investment (FDI) is a long-term investment made by a private firm in the production of goods or services in
another country.
MNC's and FDI:
*It is being understood that the forces of economic globalization requires looking first at foreign direct investment (FDI) by
multinational corporations (MNC's).
•The study of FDI and MNCs is both fascinating and important for understanding economic globalization.
*The movement of private foreign capital takes place through the medium of MNC's. Thus, they are important sources of
FDI.
*There are three main methods of foreign investment by Multinational Companies: (i) Agreement with local firms for sale of
MNCs products. (ii) Setting up subsidiaries. (iii) Creating markets for their products.
INTERNATIONAL LABOUR MOBILITY-Labour Mobility (Meaning): • Labour or worker mobility is the geographical and
occupational movement of workers. • Increasing and maintaining a high level of labour mobility allows a more efficient
allocation of resources.
International Mobility (Meaning): *International labour mobility is the movement of workers between countries (example
of international factor movement). *This movement is due to differences in resources between countries. • Over a period of
time the migration of labour does have an equalizing effect on wages with workers in the same industries garnering the same
wages.
Impediments: *Labour is relatively immobile and does not readily move from employer to employer, from occupation, to
occupation or from one area to another, even with considerable wage differences.
*It is expensive and inconvenient for the workers to move from one area to another and they are afraid of losing working
time.
*A worker has to take into consideration non-economic as well as economic factors and to consider the long-run as well as
his immediate prospects.
*There are many restrictions on shopping around in other labour market.
*Unemployment may become an obstacle to mobility.
• According to Joan Robinson that workers are influenced almost entirely by the chance of finding a job and that relative real
wages exercise only a slight pull upon movements of labour.
*The worker may lose seniority which he may achieve in his present job, if he moves to a new job. As a new employee in
another organisation he may be laid off first in case of a situation.
• Recent practices and attitudes of employers reduce the mobility of labour. Past has proved that the free market failed to
supply enough jobs that could support a bare minimum of subsistence making labour mobility no solution to insufficient or
low wages.
• Other impediments includes: (i) Discrimination based on social class. (ii) Systems of economics that impede workers.
BALANCE OF PAYMENTS: INTRODUCTION, CONCEPT AND IMPORTANCE-• An open economy undertakes a variety of
economic transactions with the rest of the world. These transactions play an important role in the complex mechanism of its
development, the achievement of social and economic welfare by its citizens, stability of income, prices and employment
etc.
*There is an inescapable interdependence between the domestic economy and the rest of the world. Due to this reason the
concept of balance of payments and the issues associated with it becomes highly complex and intricate.
*The balance of payments of a country is the differences between all money flowing into the country in a particular period of
time and the outflow of money to the rest of the world.
*BOP Account of a country is a systematic and aggregative recording of the monetary value of all transactions between its
residents and the rest of the world during a given time period.
• It is prepared on the principle of double-entry book-keeping. All earnings and payments received are recorded as credits
and all expenditure and payments made are recorded as debits.
Concept: Definition: *BOP account of a country is a classified summary of the monetary value of its international
transactions, in some form of aggregation, pertaining to a given period of time.
*Transactions are recorded on the basis of the direction of payments, incoming payments are recorded as credit entries and
outgoing payments are recorded as debit entries.
Parts of BoP Account: • Reserve Bank of India data shows the values of the components in both Indian Rupees and US
dollars.
(i) Imports (c.i.f.) (ii) Exports (f.o.b.)
(iii) Trade balance (2-1) : It is known as merchandise trade balance, visible trade balance, trade balance in tangible goods.
• The three above mentioned aggregates are collectively known as Trade Account.
(iv) Invisible Account: It represents receipts and payments on account of: (a) "Selling" and "buying" of services and (b) Grants
and other unilateral transfers gifts, charities, pensions, remittances etc.
(v) Current Account : This account adds the Trade Account and Invisible Account. Balance in current account less or the
algebraic sum of trade balance and balance on invisibles.
(vi) Capital Account: This account covers external transactions of a country in financial assets and liabilities.
(a) Foreign Investment: In addition to the usual aggregates such as (i) Receipts, (ii) Payments and (iii) Net. RBI also provides
several further details of these transactions.
(b) Loans: • Presentation of data in this account is as detailed as in the case of foreign investments.
(c) Banking: It consists of (1) Receipts, (ii) Payments, (iii) Net and other details (d) Rupee Debt Service (e) Other Capital: (i)
Receipts, (ii) Payments, (iii) Net. (f) Errors and Omissions
(vii) Total Capital (viii) Overall balance (Ix) Monetary movement (x) Total
Importance of Balance of Payments:
*A BOP statement can be used as an indicator to determine whether the country's currency value is appreciating or
depreciating.
*It assists the Government to decide on fiscal and trade policies.
*The BOP statement provides important information for analysing and understanding the economic dealings of a country
with other countries.
• A country's balance of payments tells you whether it saves enough to pay for its imports.
*It also reveals whether the country produces enough economic output to pay for its growth.
INTERNATIONAL MONETARY STANDARDS: INTRODUCTION AND CONCEPT-• An international monetary system is a set of
internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border
investment and generally the reallocation of capital between nation states. Monetary Standards:
(i) The Era of Bimetallism: • This system prevailed before 1870 where both gold and silver coins were used as the
international modes of payment.
*The exchange rate among the different currencies were decided by the gold or silver contents.
• Some countries used the Gold standard and some countries used the silver standard.
(ii) Gold standard: *This standard prevailed from 1875 to 1914 and gold alone was used for unrestricted coinage. • There was
a two, way convertibility between gold and national currencies at a stable ratio,
*There were no restrictions on the export and import of gold.
• The gold content decided the exchange ratio.
*However, there gold standard ended in 1914 during World War I
• Major nations such as Great Britain, France, Germany and many other countries. imposed embargoes on gold exports and
suspended redemption of bank notes in gold.
• During the inter-war period the U.S. replaced Britain as the dominant financial power of the World. The US in 1919
returned to the Gold Standard.
• Many countries followed a policy of sterilization of gold by matching the inflows and outflows of gold with changes in
domestic money and credit.
(iii) Gold Exchange Standard: • After World War II the Bretton Woods system was established and existed during the period
1945-1972.
• In 1944, 44 nations met at Bretton Woods, New Hampshire and designed a new post-war International Monetary System.
• This system a system (exchange standard) that included both gold and foreign exchanges. Under this system each country
established a par value relation to the US dollar, which was pegged to gold at $35 per once. However, in 1970 these Gold
Standard collapsed.
• The International Monetary Fund created a new reserve asset called Special Drawing Rights (SDRs).
*In 1981, the SDR was restructured to constitute only five major currencies. US dollar, German Mark, Japanese Yen, British
Pound and French Franc.
*In 1971, the Smithsonian agreement signed by 10 major countries made changes to the Gold Standard.
*However, the Smithsonian Agreement also proved ineffective and the Bretton Woods system collapsed.
(iv) Flexible Exchange Rate Regime: • The European and Japanese currencies became free floating currencies in 1973, and
the flexible exchange rate regime was formally ratified in 1976 by IMF members. (Jamaica Agreement)
*Gold was officially abandoned as the international reserve asset.
*In a free-floating or independent floating currency, the exchange rate is determined by the market with foreign exchange
intervention, occurring only to prevent undue fluctuations.
*In a managed, floating system the central monetary authority of countries influenced the movement of the exchange rate
through active intervention in the forex market with no preannounce path for the exchange rate.
*In a fixed peg arrangement the country pegs its currency at a fixed rate to a major currency or to a basket of currencies.
GAINS FROM TRADE-STATIC AND DYNAMIC-Gains from Trade-"The gains on account of the advantages of division of labour
and specialisation at both national and international level are called gains from trade."
• The tremendous expansion of international trade is in itself the best proof that countries gain from trade.
• The gains from trade refer to net benefits or increases in goods that a country obtains by trading with other countries. It
also means the increase in the consumption of a country resulting from exchange of goods and specialisation in production
through international trade.
*The theory of gains from trade was at the core of the classical theory of international trade. For Ricardo, extension of
international trade very powerfully contributed to the increase in the mass of commodities.
The gains from international trade are as • It encourages the development of the most efficient sources of supply.
• International specialisation and the economies in production make goods available comparatively cheaper.
*International trade enables specialisation on a large scale because of the expanded market, and hence economies of scale
are realised. On the other hand, when the size of the market is limited, certain investments are uneconomical.
*International trade increases real incomes and consumption. This could lead to expansion of employment and output and
encourage economic growth Trade on international scale makes available even those goods that cannot be domestically
produced.
*Trade enables a country to conserve certain scarce resources, as commodities which embody these scarce resources may
be imported from nations where they are in abundance.
Sources of Gains from Trade-The main sources of gains from trade are as under 1. Division of Labour: According to Ricardo's
theory of comparative costs "when different countries of the world specialise in the production of those goods in which they
enjoy greater comparative advantage or they have least comparative disadvantage, then all the trading countries will stand
to gain". Thus one of the main sources of gain from trade is division of labour on the basis of comparative costs.
2. International Specialisation: Another main source of gain from international trade is specialisation based on the
comparative cost advantage. It makes possible large-scale production, which in its turn yields internal and external
economies. These economies give rise to gains from trade.
3. Wide Extent of Market: Wide extent of the market leads to increase in scale of production. Scope of division of labour and
specialisation widens. Cost of production falls leading to fall in the price of the commodity. It also constitutes gain from the
international trade.
Kinds of Gain from Trade: Static and Dynamic Gains-*Countries and people would have no incentive to trade if they did not
gain from trading. In fact, countries engage in trade with one another because they gain from trade. Thus, the main reason of
trade resides in the gains which countries reap from trading with one another.
*The gains from trade can be classified as Static and Dynamic Gains.
*J. S. Mill called the gains as "direct" and "indirect" gains, whereas Modern economists refer to these gains as "Static" and
"dynamic" gains.
(A) Static Gains from International Trade: • In this case, each country gains from trade when the total output of goods
increases as a result of the extension of division of labour and specialisation.
*Under the static gains from trade the producers in the country move along the same production frontier. The frontier itself
remains unchanged, ie, the production possibility curve (PPC) of the country is assumed as given.
• As for the consumers, the consumption frontier expands as their aggregate consumption increases
• Thus, Static gains refer to gains that are due to reallocation of resources in accordance with comparative advantage. It
refers to a one-time change to a higher level of income
*Static gains are normally measured ex-post, i.e., after the transaction is over. It is a comparison between two equilibrium
positions that can be compared only after they have been reached.
• Static gains are measured at a point of time and not over a period of time. • The Ricardian theory of Comparative Costs, on
static gains, explains that it is possible for both the trading countries to benefit even when one of the countries is more
efficient than the other in all the lines of production. The theory explained that as long as the country could import a
commodity at a relatively lower price than the price when produced at home, there would be gains from trade.
• The H-O theory explained the static gains from trade based on abundant factor supply. The use of the abundant factor
allows each country to produce goods at a cheaper rate. For example, the capital-rich country can produce capital-intensive
goods at a cheaper rate, while labour-rich nation can produce labour-intensive goods at a relatively lower rate. International
trade can lead to mutual benefit in terms of static gains with each transaction.
• The Static Gains from international trade can be summarised as under.
(a) Maximisation of Production: • Trade maximises production. According to the classical economists, the gains from trade
result from the advantages of division of labour and specialisation both at the national and international levels. It is
specialisation in production on the basis of comparative advantage and trading which enables each country to exchange its
goods for the goods of another country. Thus it reaps greater gain than without trade.
• According to Ricardo, "The gains from trade consisted in the saving of cost resulting from obtaining the imported goods
through trade instead of domestic production".
(b) Increase in Welfare of People: • With specialisation and division of labour, the production of goods increases in the
trading country and thus increases the consumption of goods and so does increase the welfare of the people. According to
Ricardo, "the extension of international trade very powerfully contributes to increase the mass of commodities and thus the
sum of enjoyments".
(c) National Income: • With gains from international specialisation and exchange of goods in trade, the country experiences
increase in national income; this in turn raises the level of output and growth rate of the economy.
(d) Provides an Opening for Surplus: • When the country opens to world markets, its resources are used to produce a surplus
of goods which would otherwise remain unsold. This is Adam Smith's vent for surplus gain from trade.
• Static gains from trade are measurable. Jacob Viner has developed three different methods for measuring the national
gains (advantages) from international trade.
• These 3 methods are- 1. Economy in the cost of obtaining a given real income measured with the help of comparative costs
principle. 2. Increase in the National Income of the country. 3. Improvement in terms of trade as an index of the international
distribution and trend of gains from trade.
• The first two methods are identical when referred to a point of time. Any specific amount of gain can be expressed either
as a reduction in the cost per unit of the real income or as an increase in real income per unit of cost.
*These two methods require a lot of necessary information which is not easy to collect. Further, its computation requires
immense labour and skill with precision Due to this economist to measure the absolute gains from trade at a given point of
time adopt the third method, Le, improvement in the terms of trade, as an indicator of the gains from international trade.
(B) Dynamic Gains from International Trade: • In Static Gains the consumers were given the opportunity to purchase a
product more cheaply that was relatively dearer before the international trade.
*However, the consumers were not introduced to any new product. Similarly, the producers reallocated their productive
resources in accordance with the new set of prices open to them with commencement of trade. But no new technology
which could bring surge in their production frontiers was introduced. It implies that the production frontier (production
possibility curve) remains unchanged. It is only the community's consumption frontier expands as a result of trade.
*International trade brings more than the Static Gains. It brings in some fundamental measurable changes in the domain of
consumption and production.
*Dynamic Gains refer to gains that have the power to force a change and explain how an economy can achieve a higher rate
of income growth over a period of time.
*Dynamic Gains are measured over a period of time.
*J. S. Mill referred to 'dynamic gains' as 'indirect gains of a higher order".
• The Modern theory links growth of the domestic economy to a country's foreign trade. This is due to the following reasons:
1. Trade Widens the Markets: • The major indirect dynamic gain from trade is that it widens the size of the market. By
enlarging the size of the market and scope of specialisation, international increases the scope of division of labour,
stimulates innovations and thus enables the trading country to enjoy increasing returns and enhance their growth.
2. Trade can Stimulate Managerial Effort: The direct dynamic gain from international trade is that comparative advantage
leads to a more efficient employment of the productive resources of the world. It improves the given efficiency arising out of
the Static Gains.
The import-competing industries will have to reduce their slackness and pursue the policy of cost reducing methods of
production. For this the producers will make use of new information and update their quality.
3. Significant for Less Developing Countries: *It allows the country to exchange goods with less growth potential for goods
with high growth potential, i.e. exchanging primary products for capital, machinery, etc.
4. Trade Encourages Changes in the Domestic Factor Supply: • Real income rises with efficient utilisation of resources and
also raises their savings capacity, resultant greater returns on investment from overseas market and encourages further
savings.
5. Trade Exposes the Domestic Country's Abilities to the World: • It helps to attract foreign capital in the form of direct
investment. Thus, providing scope for more production, employment, etc.
6. Higher Learning Curve: In a rapidly changing technological world, international trade helps in diffusion and adoption of
skills and know-how. Thus, it contributes towards the learning curve of the nation.
7. Increase in Investments: • International trade encourages the setting up of new units for assembling and production of
variety of goods. Ancillary units are established. Production for exports leads to backward and forward linkages in developing
other activities. All this leads to autonomous and induced investments in the country.
Dynamics-*International trade leads to the division of labour or specialisation on a larger scale.
• As rightly pointed out by Adam Smith, division of labour is limited by the extent of the market. The scope of division of
labour is enlarged with international trade.
*Thus, international trade increases the gain from division of labour.
*Free international trade makes available goods and services produced all over the world at the most competitive prices.
•When there is free trade, goods and services produced all over the world are available to people everywhere.
*International trade makes available to the people of a country a galaxy of goods and services at the most competitive
prices.
• A country may not be endowed with factors or any technological capability to produce certain goods.
* In absence of trade with other countries, it will have to do without such goods, but due to international trade it is able to
procure these goods.
Factors Influencing Gains from Trade-Factors that determine the gains from international trade are:
(a) Demand and Supply: If a country has elastic demand and supply gains, the gains from trade higher than when demand
and supply are inelastic.
(b) Differences in Cost Ratio: The gains from international trade are influenced by the cost ratios of differences in
comparative cost ratios in the two trading countries. The smaller the difference between exchange rate and cost of
production, smaller the gains from trade and vice versa.
(c) Factor Availability: International trade is based on the specialisation which in turn depends upon the availability of factors
of production. It will increase the domestic cost ratios and then the gains from trade.
(d) Terms of Trade: Gains from trade will depend upon the terms of trade. If the cost ratio and terms of trade are closer to
each other more will be the gains from trade of the participating countries.
(e) Productive Efficiency: An increase in the productive efficiency of a country also determines its gains from trade as it lowers
the cost of production and price of the goods. Consequently, the country importing gains by importing cheap goods.
(f) Size of a Country: If a country is small in size it is relatively easy for them to specialise in the production of one commodity
and exports the surplus production to a large country and can get more gains from international trade. On the other if a
country is large in size then it can specialise in more than one good because the excess production of only one commodity
cannot be exported fully to a small-sized country because the demand for good will reduce very frequently. Hence smaller
the size of the country larger is the gain from trade.
Gains from Trade Measurement- • According to Classical Economist there are two methods to measure the gains from
trade. (a) International trade increases national income which helps us to get low priced imports:
(b) Gains are measured in terms of trade.
• To measure the gains from trade, comparison of cost of production between domestic and foreign countries is required.
However, it is very difficult to acquire the knowledge of cost of production and cost of imports in a domestic country.
*Therefore, terms of trade method is preferable to measure the gains from trade.
Static Gains from Trade-*Static gains mean increase in social welfare as a result of maximised national output due to
optimum utilisation of country's factor endowments or resources. *Static gains are the result of the operation of the theory
of comparative cost in the field of foreign trade. *On principle of comparative cost, countries make the optimum use of their
available resources so that their national output is greater which also raises the level of social welfare in the country. *When
there is an introduction of foreign trade in the economy the result is called the static gains from trade.
Dynamic Gains from Trade-*Dynamic gains from trade are those benefits which accelerates economic growth of the
participating countries. *Dynamic gains from trade relate to economic development of the economy. *Specialisation of the
country for the production of best suited commodities which result in a large volume of quality production which promotes
growth. *The extension of domestic market to foreign market will accelerate economic growth.
WELFARE COMPARISONS AT INTERNATIONAL AND DOMESTIC LEVEL-List of countries by Human Development Index-*The
United Nations Development Programme "Programme (UNDP) ranks countries into four tiers of human development by
combining measurements of life expectancy, education, and per-capita income into the Development Index (HDI) in its
annual Human Development Report. Human
*The HDI is a summary index using life expectancy at birth, expected years of schooling for children and mean years of
schooling for adults, and GNI per capita. The final HDI is a value between 0 and 1 with countries grouped into four categories
depending on the value, very high for HDI of 0.800 and above, high from 0.700 to 0.799, medium from 0.550 to 0.699 and
low below 0.550.
*The Human Development Report has been published most years since 1990. The 2019 report contained the HDI of 189
countries and territories and 15 regions or groups of countries based on data collected in 2018.
• In the 2010 Human Development Report, a further Inequality-adjusted Human Development Index (IHDI) was introduced
assessing countries on a fourth dimension of inequality. The report stated that while the HDI remains useful, "the IHDI is the
actual level of human development (accounting for inequality)" and "the HDI can be viewed as an index of 'potential' human
development (or the maximum IHDI that could be achieved if there were no inequality)".
List of Indian states and territories by Human Development Index • The national average HDI for India in 2008 was 0.467.
By 2010, its average HDI had risen to 0.519. Human Development UNDP, the sponsor of Human Development Index
methodology since 1990, reported India's HDI to be 0.554 for 2012, an 18% increase over its 2008 HDI. United Nations
declared India's HDI is 0.586 in 2014, a 5.77% increase over 2012. As for the year 2018, HDI for India stood at 0.647.
*HDI is composite index that takes into consideration (1) health, (2) Education and (3) Per capita income.

CH 4 Trade policy and role of int eco

organisation
Introduction-*Trade policy refers to the regulations and agreements that control imports and exports to foreign countries.
The World Bank group supports an open, rule based, predictable international trading system surveillance of national trade
policies is a fundamentally important activity running throughout the work of WTO.
*The IMF's mandate includes assisting the expansion and balanced growth of international trade, promoting exchange
stability etc. This chapter also discusses the tariffs, protection policy, Exchange rates etc.
FREE TRADE POLICY: MEANING, ARGUMENTS FOR AND AGAINST-Introduction-*The choice of trade policy is one of the most
important economic policy decisions a country has to make due to its wide implications. The trade policy refers to the system
of government interference in foreign trade.
*The nature of trade policy (or government interference) has its impact not only on the volume and composition of imports
and exports but also on the pattern of investment and direction of development, cost conditions, consumption patterns, etc.
Meaning of Free Trade-•Free Trade policy refers to a trade policy without any tariffs, quantitative restrictions and other
devices obstructing the movement of goods between countries.
Arguments for Free Trade-• The Classical economists were in favour of the free trade policy. Of the Modern economists,
Haberler advanced the following arguments in favour of free trade.
1. Maximisation of Output: The case for free trade arises from the theory of comparative advantage. Therefore, under free
trade a country specialises in the production of those commodities which it is relatively best suited to produce and exports
them in exchange for those imports which it can obtain cheaply.
• This maximises the output of all the participating countries because all gains from trade, in turn, increases the real national
income of the world economy. Thus, free trade leads to the maximisation of output.
2. Optimum Utilisation of Resources: • Free trade leads to international specialisation and division of labour. As a result, the
existing resources in each trading country are employed more productively and the resource allocation becomes more
efficient.
*There is more efficient utilisation of factors within a firm or industry. In other words, international trade and division of
labour lead to optimum utilisation of resources.
3. Benefits to the Consumers: *The indigenous industrialists have to compete with the foreign industrialists under the policy
of free trade. Hence, they try to sell their products at cheap prices by cutting down their production costs.
*Moreover, there are no import duties on imported goods under free trade; consumers are able to buy a variety of
commodities from abroad at the minimum possible prices. This has an effect of raising their standard of living.
4. Wider Market: Free trade leads to wider and more extensive markets for goods. As the demand for goods is not confined
to one country but to a number of countries, the entire world becomes the market for all types of goods. This leads to the
production of quality goods at low prices because of world competition.
5. Check on Monopolies: • Free trade prevents the establishment of monopolies. Under free trade each country specialises in
the production of a few commodities and the firms or industries are of the optimum size so that the cost of production of
each commodity is the minimum.
• Thus, free trade ensures a lower price for exports as well as for imports and the price mechanism under perfect
competition prevents the formation of monopolies. Further, since home industries have to face the competition of foreign
industries, they cannot set up monopolistic combines to maximise their profits.
6. Educative Value: • According to Haberler, free trade has educative value. International competition encourages home
producers to sacrifice leisure in order to increase productivity. For this, they innovate and bring improvements in the
organisation and methods of production.
7. Cooperation and Goodwill amongst Different Nations: *Countries following the policy of free trade soon become
dependent on each other for the supply of various commodities. The existence of close commercial contacts produces an
atmosphere congenial to mutual cooperation and goodwill amongst the countries concerned.
8. Economic Development of Underdeveloped Countries: • Free trade can promote economic development of
underdeveloped countries. This can be done in four ways: (a) underdeveloped countries can import capital goods and
essential raw materials required for their economic development; (b) necessary technical know-how, managerial talents,
etc., can be imported; (c) capital movement assists in economic development; (d) promotes free competition and checks
injurious and inefficient monopolies
• Due to the above-mentioned advantages the old Classical economists gave firm support to the policy of free trade.
Arguments Against Free Trade-• The policy of free trade, with all its advantages, was abandoned after the Great Depression
by the countries of the world. There are certain theoretical and practical difficulties in following the free trade policy:
1. No Laissez-faire: Trade Policy and Role of International Economic Organisation
• Free trade presupposes the existence of laissez-faire and the working of price mechanism under perfect competition. But
these conditions do not exist in the present day world. Monopoly, monopsony, cartels, imperfect labour markets and tariffs
led to the abandonment of free trade.
2. One-sided Development of the Economy: Under the policy of free trade, some industries expand in which the country
possesses comparative advantage but other industries are not developed. An agricultural country may develop only
agriculture and neglect the industrial sector, or one type of industry may be developed while others may remain
undeveloped. This leads to one-sided development of the economy, hence free trade had to be abandoned.
3. Neglects Social Welfare: *There being no restrictions on the movement of goods under free trade, substandard and
harmful commodities are likely to be produced and traded. This leads to diminution of social welfare. Trade restrictions on
the import of such commodities become essential. This was another cause for the abandonment of free trade.
4. Severe Competition: • Countries with better factor endowments are able to produce certain commodities cheaper than
others. This led to cut-throat competition in the world markets under free trade. Thus, certain countries like Japan resorted
to the policy of dumping whereby they would sell huge quantities of their products at rock-bottom prices in the foreign
markets. Naturally, this policy led to the imposition of trade restrictions.
5. International Monopolies: • Free trade may lead to the emergence of international monopolies and local monopolies.
According to Haberler, such monopolies developed under free trade which proved harmful to other countries and to the
domestic interest. This factor led to the adoption of the policy of protection.
6. Exploitation/Colonisation: • Economists do not agree with Haberler that the free trade policy helps in the development of
underdeveloped countries. Rather, his policy led to the exploitation and colonisation of countries during the 19th and early
20th centuries.
*It is now recognised that underdeveloped countries can develop under the policy of protection and not of free trade.
PROTECTION POLICY: MEANING, ARGUMENTS FOR AND AGAINST-Meaning of Protection- • Commonly, the term
'protection' means a commercial policy which is adopted by a country to encourage domestic industry by shielding its high-
priced products against competition from cheap imports either by import duties or by import quotas or by banning imports
altogether or the domestic industries may be paid subsidies or bounties to enable them to compete with cheap foreign
goods.
• A protective trade policy pursued by a country seeks to maintain a system of trade restrictions with the aim of protecting a
large portion of its domestic industry from the competition of cheap foreign goods.
• According to Harry G. Johnson, the term 'protection' refers to those "policies that create a divergence between the relative
prices of commodities to domestic consumers and producers and their relative prices in world markets".
Arguments in Favour of Protection-• All the arguments that have been put forth in support of protection are not so simple
and clear-cut as are the arguments for free trade. The arguments may be grouped under the following three broad
categories:-
1. Economic Arguments; 2. Non-Economic Arguments; 3. Fallacious Arguments.
1. Economic Arguments: Some of the strong economic arguments for protection are as follows:
(a) Terms of Trade Argument: *This argument is given to correct disequilibrium in the Balance of Payments of a country. It is
argued that the imposition of a tariff on imports improves the rate at which the country's exports are exchanged for imports.
*This means that a tariff improves its terms of trade because the foreign exporter is forced to pay some part of the import
duty. However, the extent to which a country can improve its terms of trade by imposing import duty will depend upon
relative demand and supply elasticities at home and abroad. A country which imports a large quantity of a particular
commodity (ie, demand is less elastic) will be in a better position to impose a tariff duty and improve its terms of trade.
Criticism (Adverse effects on the tariff imposing country)
(i) The terms of trade may be improved but the volume of trade of tariff-imposing country is reduced. (ii) The imposition of
tariff increases the price of the imported commodity to the domestic consumers.
(iii) It may lead to retaliation by the other country. *Therefore, too high a tariff leads to the reduction in consumer's
satisfaction, mal- allocation of domestic resources, reduction in the volume of trade and retaliatory tariffs.
(b) Bargaining Power Argument: • The protection policy is adopted to increase its bargaining power in commercial matters in
relation to other countries. It is able to get more favourable terms for its exports from other countries.
• Since international trade is based on reciprocal basis, tariff is used as a weapon to persuade or dissuade the other country
to lower its tariff wall. Thus, the fear of tariffs may induce countries to give reciprocal concessions to each other.
• Criticism: This argument for protection faces certain criticism: (i) Tariffs as a weapon for bargaining may lead to retaliation
on the part of the other country, thereby harming both the countries. (ii) Vested interests may be created in the country,
which may be so powerful that they may not allow reduction in tariffs and reciprocal bargaining.
(c) Anti-Dumping Argument: • Protection is advocated against the practice of dumping. Dumping means selling a product in
a foreign market at a lower price than in the home market, after taking into account transport and other costs of transfer.
*Dumping aims at flooding a foreign market with low-priced commodities. As a result, the firms competing are ruined. To
protect such firms, a high tariff is imposed.
• This will raise the price of the product in the importing country and removes the threat of dumping.
(d) Argument for Diversification: • Another argument advanced in support of protection is that it helps in diversification of
industries. It implies that there should be a balanced growth of the economy.
• For this purpose, agriculture and manufacturing industries should be protected from foreign competition. This is a valid
argument as experience has shown that countries which are not developed in a balanced manner are affected by
international economic disturbances such as depression, inflation, war, etc.
• Thus, the economy should diversify itself and become self-sufficient by protecting their industries. Criticism:
(i) Even the most developed state or richest country cannot diversify completely and attain self-sufficiency. In fact no country
has all the resources for a balanced growth of the economy and it has to depend upon other countries in one way or the
other.
(ii) Moreover, protection is not the only means to diversify an economy.
(e) Argument for Socially Important or Key Industries: • Protection should be given to socially important industries, such as,
agriculture or strategically important industries like iron and steel, heavy electrical, machine To making, heavy chemicals etc.
*There is no dispute over this argument because the development of key and other socially important industries under
protective tariffs is one of the principal aims of trade policy in a country.
2. Non-Economic Arguments: • It is rather difficult to draw any sharp dividing line between 'economic' and 'non- economic
arguments for protection. However, certain non-economic arguments forwarded in favour of protection are as under. (a)
Defence Argument:
• The supporters of protection argue that economic independence is of vital importance for the development of a nation. A
nation should be least dependent upon others for its defence requirements. The industries producing military equipment
must be developed in the country. It is unwise to have sources of supply of essential war materials located in another
country.
Even Adam Smith, a staunch supporter for free trade, remarked: "Defence is much more important than opulence". Thus
industries supplying essential military requirements, unable to face competition in peace time, should be protected even if
they involve a heavy economic loss to the nation.
Criticism: (i) In modern times, with high degree of horizontal and vertical linkages, t is too difficult to draw any precise
dividing line between 'military' and 'non-military' industries. There is hardly any industry which in some way or the other
does not produce commodity which is directly or indirectly not required to maintain the industry producing military
equipments.
(ii) Thus, every industry agriculture or manufacture - will exaggerate its own importance to get protection. In this sense, the
whole economy will need protection.
(iii) This will bring inefficiency since national resources will be diverted from more to less efficient uses.
• However, freedom should be protected at all costs but the government should draw a logical dividing line between
'essential' and 'non-essential' industries and protect only essential industries.
(b) Preservation Argument: • Protection is advocated to promote the growth of some specific industry, or the desire to
preserve a certain way of life, isolated from foreign influences. A country is willing to pay certain economic price for the
attainment of this social objective.
*For example, if India wants to preserve the Indian Handloom Weavers' as a token of her traditional way of life, India should
impose heavy import duty on cheap foreign mill-made textiles.
*This argument for tariff is non-economic and is largely based upon sentimental feelings.
3. Fallacious Arguments: (a) Keeping Money at Home Argument: *This argument is attributed to Abraham Lincoln. The
argument is, "when we buy manufactured goods from abroad we get the goods and the foreign country gets the money.
When we buy the manufactured goods at home we get both - the goods and the money".
Fallacy: This argument is illogical because: (i) If every country were to follow this rule, there would be no international trade
and the benefits of it would not accrue to any country of the world. (ii) A country purchases goods from another country
because the latter offers them at lower prices than the domestic manufactures. Buying goods produced by domestic
manufacturers would, therefore, mean loss to the consumers. (iii) In international trade goods pay for goods and money
(gold) moves from one country to another only to adjust the balance of payments disequilibrium. The currency of one
country is useless for the other unless the country spends it on the purchase of goods in that country.
(b) Expanding Home Market Argument: *This fallacious argument is a corollary to the above argument of keeping money at
home. It is argued by the protectionists that tariffs cause expansion of the home market by reserving the home market for
the domestic goods.
*If a country's manufacturers are protected they will expand the home market for agricultural products. The rise in
agriculturist's incomes will generate additional demand for manufactured goods. As a result, the whole market will be
expanded and the size of the home market for the products will become larger."
Fallacy: (i) This argument has been criticised on the ground that while the home market expands but the export market
contracts. Thus, the home market expands at the expense of foreign market and protection may not bring any gain by the
expansion of home market.
(ii) Keynes argues that when imports are restricted by the imposition of tariff duties, exports also declines because the other
countries would retaliate. He argues that imports are our payments and exports are receipts, How, as a nation, can we
expect to better ourselves by diminishing our receipts?
(iii) Moreover, domestic producers will charge higher prices for the products of domestic industries and the consumers will
be the losers.
(c) Equalising Cost of Production Argument: Protection to domestic industries is advocated for equalising costs of production
of domestic and foreign products. For example, if the domestic costs are higher than foreign costs by 25% an import duty of
25% should be imposed on foreign products.
*In this way the costs of production of both domestic and foreign products are equalised and they can now compete on
equal terms.
Fallacy: (i) According to Taussig, this argument has an appearance of fairness, ie, the fairness is only apparent. The imposition
of very high import duties by all countries would lead to the destruction of international trade.
(ii) Ellsworth considers the protection policy as discriminatory in nature. It discriminates in favour of inefficient producers
and is against the efficient ones. Such a policy would lead to giving protection to the least efficient industries with high cost
of production.
Arguments Against Protection-1. Uneconomic Use of Resources: Protected industries are generally those in which a country
has less comparative advance. Thus, protection leads to the development of economically less proficient industries and
transfer of natural resources of the country from more productive businesses to less productive businesses.
2. Producers Become Lethargic: Protection makes the home producers lethargic. In the absence of competition from foreign
firms, the home country producers do not bother to reduce the cost of production in their units and therefore will not be
able to make them more efficient.
3. Check on Industrial Growth: Protection once given to an industry is taken as a matter of right and thus cannot be easily
removed, Protection tends to become a stable feature and the protected industry persists to be considered as an infant
industry.
4. Does not Cure Unemployment: Protection may not prove to be a successful method of generating employment. The
creation of employment because of the expansion of the protected domestic industries may be counterbalanced by
reduction in employment due to the consequential decline in exports.
5. Loss to Consumer: The eventual burden of protection falls on consumers. Protection leads to restriction on inexpensive
imports and rising of domestic prices. The consumers suffer from these effects.
6. Unequal Distribution of Income: Protection promotes uneven distribution of income and wealth. Under protection, the rich
(producers) become richer because of high profits in the protected industries and the poor (consumers) become poorer
because of higher prices.
7. Creation of Monopolies: Tariff is considered the mother of trusts. In the absence of foreign competition, domestic
producers combine to collect higher returns.
TARIFF BARRIERS AND NON-TARIFF BARRIERS: COMMERCIAL POLICY AND PREFERENTIAL TRADE AGREEMENTS
Tariff Barriers: Introduction-*Though there are a number of advocates of free trade, international trade is generally
characterised by the existence of various trade barriers or trade restrictions. International trade is restricted by tariffs and
non-tariff measures Thus, trade barriers can be broadly classified into two groups (1) Tanff Barriers and (2) Non-tariff Barriers
*When it comes to explaining tariffs, we need to start by distinguishing tariff barriers (which directly affect either prices) and
non-tanff barers (which may directly affect either price or quantity)
*Tariffs in international trade refer to the duties or taxes imposed on internationally traded products when they cross the
national borders
*A tariff, also called a duty, is the common type of trade control and tax that government levy on a good shipped
internationally.
*Governments charge a tariff on a good when it crosses an official boundary whether it be that of a nation, say Mexico, or a
group of nations like the EU, that have agreed to impose a common tariff on goods entering their block
*Tariff is a very important instrument of trade protection. However, mostly because of the efforts of the WTO aimed at trade
liberalisation, in the industrial countries, there has been a substantial reduction in the tariffs on manufactured goods over
the last fifty years
*Although the tariff rates are still fairly high in the developing countries, many of them have also been progressively reducing
the tariff levels. It is also true that WTO prefers tariff barriers to non-tariff barriers as tariffs are generally regarded as less
restrictive than other methods of protection like quantitative restrictions.
Classification of Tariffs-*On different criteria, we can classify tariffs as discussed below:
(A) On the basis of the origin and destination of the goods crossing the national boundary, tariffs may be classified into
three categories:
(1) Export Tariffs: An export duty is a tax imposed on a commodity originating from the duty-levying country destined for
some other country. That is, tariffs collected by the exporting country are called export tariffs.
(ii) Transit Tariffs: A transit duty is a tax imposed on a commodity crossing the national frontier originating from and destined
from other countries. That is, if tariffs are collected by a country through which the goods have passed, they are transit tariffs
(iii) Import Tariffs: An import duty is a tax imposed on a commodity originating abroad and destined for the duty-levying
country. That is, tariffs collected by importing countries are called import tariffs. Import tariffs are by far the most common
tariffs.
*Import tariffs raise the price of the imported goods by placing a tax on them that is not placed on domestic goods, thereby
giving domestically produced goods a relative price advantage.
*A tariff may be protective even though there is no domestic production in direct competition. For example, a country that
wants its residents to spend less an foreign goods and services may raise the price of some foreign products, even though
there are no close domestic substitutes, to curtail demand for imports
(B) On the basis for quantification of the tariff, tariffs may be classified into the following three categories:
(i) Specific Duties: • A government may assess a tariff on a per unit basis, in which case it is applying a specific duty. Thus, a
specific duty is a flat sum per physical unit of the commodity imported or exported. Thus, a specific import duty is a fixed
amount of duty levied upon each unit of the commodity imported.
(ii) Ad valorem Duties: *A government may assess a tariff as a percentage of the value of the item, in which case it is an ad
valorem duty. Thus, these duties are levied as a fixed percentage of the value of commodity imported or exported.
*Thus, while the specific duty is based on the quantum of the commodity imported/exported, the ad-valorem duty is based
on the value of the commodity imported/exported.
(iii) Compound Duties: • When a commodity is subject to both specific and ad-valorem duties, the tariff is generally referred
to as compound duty. Thus, if it assesses both a specific duty and ad valorem duty on the same product, the combination is a
compound duty.
*A specific duty is straightforward for customs officials to assess because they do not need to determine a good's value on
which to calculate a percentage tax.
*The raw materials frequently enter developed countries free of duty, however, if processed eg coffee beans to instant
coffee powder, developed countries then assign an import tariff, because an ad valorem tariff is based on the total value of
the product, meaning the raw materials and the processing combined.
• Developing countries argue that the effective tariff on the manufactured portion turns out to be higher than the published
tariff rate. For example, a country may charge no duty on coffee beans but may assess a 10% ad valorem tariff on instant
coffee. Thus, if $5 for a jar of instant coffee covers $2.50 in coffee beans and $2.50 in processing costs, the $0.50 duty is
effectively 20% on the manufactured part as the coffee beans could have entered free of duty. This challenges the
developing countries to find markets for their manufactured products.
(iv) Sliding Scale Import Duty: • Sliding scale import duty is imposed on ad valorem basis or on specific basis. Often, slicing
scale import duty is levied on a specific basis. For example, no import duty is imposed on 1 watch brought into the country by
an Indian tourist returning from a trip abroad. Then, 50 is charged per watch imported between 50 and 100 watches and
may be 100 per watch on imported watches for the quantity of 101 and 200 and so on.
(C) On the basis of its application between different countries, the tariff system may be classified into three categories : •
Single-Column Tariff: This tariff is also known as uni-linear tariff system, which provides a uniform rate of duty for all like
commodities without making any discrimination between countries.
*Double-Column Tariff: Under this system there are two rates of duty on some or on all commodities. Thus, the double-
column tariff discriminates between countries.
The double-column tariff system may be further sub-divided into:
(i) General and Conventional Tariff: It consists of two schedules of tariffs ie, the general and the conventional. The general
schedule is fixed by the legislature at the start. On the other hand, the conventional schedule results from the conclusion of
commercial treatise with other countries.
(ii) The Maximum and Minimum System: It consists of two autonomously determined schedules of tariff- the maximum and
the minimum. The minimum schedule applies to those nations who have obtained the concession as a result of the treaty or
through 'Most-favoured Nation (MFN) pledge, while the maximum schedule applies to all other countries.
*Triple-Column Tariff: This system consists of three autonomously determined tariff schedules: the general, the intermediate
and the preferential. The first two i.e. the general and the intermediate tariff schedule are similar to the maximum and
minimum rates (under double-column tariff system). The preferential rate was generally applied in the case of trade
between the mother country and its colonies.
(D) On basis of the purpose that the tariff serves, it may be classified into the following three categories:
Revenue Tariff: • Tariffs also serve as a source of governmental revenue. Import tariffs are of little importance to developed
countries, usually costing more to collect than they yield. However, tariffs are a major source of revenue in many developing
countries. This is because government authorities in these countries may have more control over determining the amounts
and types of goods crossing their borders and collecting a tax on them than they do over determining and collecting
individual and corporate income taxes.
*Although revenue tariffs are most commonly collected on imports, some countries charge export tariffs on raw materials.
Transit tariffs were once a major source of revenue for countries, but governmental treatise has nearly abolished them.
*Thus, sometimes the main intention of the government in imposing tariff may be to obtain revenue. When raising revenue
is the primary motive, the rates of duty are generally low lest Imports be highly discouraged, thus defeating the aim of
mobilising revenue for the government Revenue tariffs tend to fall on articles of mass consumption.
Protective Tariff:
*This tariff is intended mainly to accord protection to domestic industries from foreign competition. In general, the rates of
duty tend to be very high, as only high rates of duty curtail imports to a significant extent.
Countervailing and Anti-dumping Duties:
• Countervailing duties may be imposed on certain imports when they have been subsidised by foreign governments. And,
anti-dumping duties are applied to imports which are being dumped on the domestic market at a price either below their
cost of production or substantially lower than their domestic prices. These two types of tariffs are generally penalty duties as
an addition to the regular rates.
On the basis of the origin and destination of the goods crossing the national boundary *Export Tariffs *Transit Tariffs *Import
Tariffs
On the basis for quantification of the tariff- *Specific Duties. Ad-Valoremn Duties. *Compound Duties *Sliding Scale, Import
Duty
On the basis of its application between different countries-*Single-Column tariff *Double-Column tariff *Triple-Column tariff
On basis of the purpose that the tariff serves-*Revenue tariff *Protective tariff *Countervailing and anti-dumping duties
Tariff Structure: Developing Countries-The prevailing tariff structures in industrial countries are highly harmful to developing
countries
*Although most tariffs in industrial nations are low, but on certain commodities it remains prohibitively high.
*Tariffs on many consumers, agricultural and labour-intensive goods are 10-20 times higher than the overall average tariff.
For example, US import tariffs on clothes and shoes average 11% and go as high as 48%. Other industrial economies are no
different.
*For example, the EU applies tariffs of up to 236% on meat, 180% on cereals, and 17% on chocolates. In contrast, its tariffs
on raw materials and electronics rarely exceed 5%.
• Developing countries that export primarily agricultural and labour-intensive goods, such as textiles, and clothing, are hard
hit by industrial countries tariff policies. For example, on imports of $2.4 billion from Bangladesh (a major clothing exporter),
the U.S. collected duties of $ 331 million in 2001 slightly more than the $330 million it collected on $ 30 billion of imports
from France.
*Thus, poor countries like Bangladesh, that are beginning to move from subsistence agriculture and dependency on exports
of primary commodities into light manufacturing, face the highest effective tariffs, on average, 4 or 5 times, those faced by
the richer economies.
*To worsen the matters further, tariffs applied to similar categories of consumer goods are often higher on the cheaper
goods than on luxury versions. For example, the U.S. tariff on imported silk shirts is only 1.9% while it is 20% on cotton shirts,
and 32.5% on synthetic fibre shirts.
*In other words, the tariff structure on these products is regressive taxes on the poor, who can least afford to pay.
*Unfair tariff structures are not limited to textiles alone. Another type of discriminatory tariff is tariff-escalation- when tariffs
increase with the of processing involved in the product. Cocoa beans are taxed at lower rate than cocoa butter, which is
taxed at a lower rate than chocolate and tariff escalation is also seen in many major developing countries.
Effects of Tariff on an Economy-Tariff affects an economy in different ways, as pointed below. 1. Protective Effect: • An
import duty is likely to increase the price of the imported goods. This increase in the price of imports is likely to reduce
imports and increase the demand for domestic goods.
*Import duties may also enable the domestic industries to absorb higher production costs. As a result of the protection given
by the application of tariffs, the domestic industries are able to expand their output.
2. Revenue Effect: A tariff means increased revenue for the government, unless of course, the rate of tariff is so prohibitive
that it completely stops the import of the commodity subject to the tariff.
3. Consumption Effect: The rise in prices resulting from the import duty usually reduces the consumption capacity of the
people.
4. Redistribution Effect: If the import duty causes an increase in the price of domestically produced goods; it amounts to
redistribution of income between the consumers and producers in favour of the producers. Further, a part of the consumer
income is transferred to the exchequer by means of the tariff.
5. Employment Effect: The tariff may cause a switch over from spending on foreign goods to spending on domestic goods.
This higher spending within the country may cause an expansion of domestic income and employment.
6. Terms of Trade Effect: In an attempt to maintain the previous level of imports to tariff imposing country, if the exporter
reduces the prices, the tariff imposing country is able to get their imports at a cheaper price. Other things being equal, this
will improve the terms of trade of the country imposing the tariff.
7. Competitive Effect: The competitive effect of the tariff is, in fact, an anti-competitive effect in the sense that protection of
domestic industries from foreign competition may enable the domestic industries to obtain monopoly power with all its
associated evils.
8. Balance of Payment Effect: Tariffs, by reducing the volume of imports, may help the country to improve its balance of
payments position.
Non-tariff Barriers-Introduction • Non-tariff barriers (NTBS), some of which are described as new protectionism measures
(tariffs are regarded at traditional barriers), have grown considerably. particularly since the beginning of 1980s. The export
growth of many developing countries has been seriously affected by NTBS.
• According to a World Bank study, NTBs in major industrial countries affect more than one-third of imports from developing
countries as compared to more than one-fourth from all countries.
The NTBs are categorised into two groups:
(i) The first group includes those tariffs which are generally used by developing countries to prevent foreign exchange
outflows, or those which are due to the chosen strategy of economic development. These traditional NTBs include import
licensing, import quotas, foreign exchange regulations and canalisation of imports.
(ii) The second group of NTBs are those which are mostly used by developed countries to protect domestic industries which
have lost international competitiveness and/or which are politically sensitive for governments of these countries. One of the
most important new protectionism measures under this group is Voluntary Export Restraint (VER).
Forms of NTB's (NTB's for Quantity Controls)-*There are different forms of NTBs. The NTBS which have significant restrictive
effects are described as hard-core NTBs. Governments use non-tariff regulations and practices to affect directly the quantity
of imports and exports. A brief account of the NTBs is given below:

1. Voluntary Export Restraint (VER): *VER is bilateral arrangements instituted to restrain the rapid growth of exports of
specific manufactured goods from Japan and the newly industrialising countries. The U.S. and the EC have, thus, regulated
the imports of several imports.
*A variation of an import quota is the so-called Voluntary Export Restraint (VER). Essentially, the government of Country A
asks the government of Country B to reduce its companies' exports to Country A voluntarily. Here, the term voluntarily is
misleading; typically either Country B volunteers to reduce its exports or else Country A may impose tougher trade
regulations.
*Procedurally, VER has unique merits. A VER is much easier to switch off than an import quota. In addition, the appearance
of a "voluntary" choice by a particular country to constrain its shipments to another country tends not to damage political
relations between those countries as much as an import quota does.
*A country may establish export quotas to assure domestic consumers of a sufficient supply of goods at a low price, to
prevent depletion of natural resources, or to attempt to raise export prices by restricting supply in foreign markets. To
restrict supply, some countries band together in various commodity agreements, such as those for coffee and petroleum,
which then restrict and regulate exports from the member countries.
2. Embargoes: *A specific type of quota that prohibits all forms of trade is an embargo. Regarding quotas, countries/group of
countries may place embargoes on either imports or exports, on whole categories of products regardless of origin or
destination, on specific products with specific countries or on all products with given countries.
*Governments impose embargoes in the effort to use the economic means to achieve political goals. For example, the U.S.
imposed embargo on Cuba, was conceived to weaken the Cuban economy and thus induce a demoralised populace to
overthrow the Communist regime.
3. "Buy Local" Legislation: • Another form of quantitative trade control is so-called 'buy local legislation. Government
purchases form a large part of the total expenditures in many of the countries; and generally governments favour domestic
producers. At times, governments specify a domestic content restriction i.e. a certain percentage of the product must of local
origin.
*Sometimes they favour domestic producers through price mechanism. For example, a government agency may buy a
foreign-made product only if the price is at some predetermined margin below that of a domestic competitor.
4. Standards and Labels: *Countries can devise classification, labelling, and testing standards to allow the sale of domestic
products but obstruct that of foreign-made ones. For example, the requirement that companies indicate on a product where
it is made provides information to consumers who may prefer to buy products from certain nations.
*In addition, countries may dictate their terms on content information to be displayed on the packaging. These technicalities
add to a firm's production costs, particularly if the labels have to be translated for each export market.
*Further, raw materials, design, and labour increasingly come from many countries, so most of the products today are of
such mixed origin that they are difficult to be sorted out. For instance, the U.S. stipulated that any cloth "substantially
altered" in another country must identify that country on its label. As a result, designers like Gucci and Versace must declare
"Made in China" on the label of garments that contain silk from China.
*The objective of standards is to protect the safety or health of the domestic population. However, some foreign companies
argue that standards are just another method of providing protection to domestic producers. Further, it is argued that
there's no way of knowing to what extent products are kept out of countries for legitimate safety and health reasons or are
arbitrarily kept to safeguard domestic production.
5. Specific Permission Requirements: • Some countries require that potential importers or exporters secure permission from
government authorities before conducting trade transactions. This requirement is called as an import or export license.
*A company may have to submit samples to government authorities to obtain an import licence. Thus, this procedure can
restrict imports or exports directly by denying permission or indirectly because of the cost, time, and uncertainty involved in
the process.
6. Foreign-exchange Control: It is a similar type of control. It requires an importer of a given product to apply to a
government agency to secure foreign currency to pay for the product. Thus, failure to grant the exchange obstructs foreign
trade.
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